Explain, with examples, the significance of the value of a goods cross-elasticity of demand in relation to its substitutes and complements. [8]

In the case of substitutes, the cross elasticity of demand for a good will always be positive. This means that as the price of one good decreases, the demand for the other also decreases, this is because the two products are perceived as alternatives to each other and as such, consumers will tend to gravitate towards the lower priced product, as long as their perceived quality is relatively close. In the case of very close substitutes such as Pepsi and Coca-Cola, we can expect the price elasticity of supply to be incredibly high as the two products are almost identical from all qualitative points of view and as such the price will be the key differentiating factor meaning that a small change in the price of one will cause a disproportionately higher number of consumers to switch which product they consume. Thus the cross-elasticity of demand for Pepsi and Coca-Cola is likely to be a very high positive value. Alternatively, in the case of weak substitutes such as motorcycles and cars, while we can expect some shift in demand when the price of either goes down, the cross elasticity is likely to be fairly low as there is not a great deal of overlap between car and motorcycle customers, thus, while a fall in the price of either will cause some customers to switch over, this change in demand is likely to be disproportionately lower than the change in price.

When it comes to complements, the cross elasticity of two good will always be negative, meaning that a fall in the price of one good will cause an increase in the demand for the other. The value will show the extent to which the two complements are necessary for each other, or the extent to which they complement each other. In the case for something such as mobile phones and mobile phone cases, mobile phones are likely to have a relatively low cross elasticity of demand to cases, as only a few customers will be swayed to buy a phone just because cases have dropped in price. This is because cases are in no way essential to having a phone. However, the cross elasticity of demand for cases in relation to the price phones is likely to be very high. This is because in order to make use of a case, one must have a phone, thus a fall in the price of phones will cause an extension in the demand for cases which will in turn lead to more potential buyers of cases and in turn more cases being bought. Other complements will likely have very close cross elasticities in relation to each other. One such example can be computer components. The cross elasticity of demand for RAM memory to processors is likely to not only be very high, but also likely to be incredibly close to the cross elasticity of demand for processors in relation to the price of RAM. This is because when purchasing such components, the customer is most likely looking to build a computer, and, as a computer cannot operate without all components, they are equally important, and as such, their cross elasticities will likely be very similar.